Moody's proposes more nuanced method for sovereign debt ratings

MOODY'S is changing the way it calculates sovereign debt ratings in response to the global financial crisis and subsequent sovereign debt crises, which exposed flaws in its the current method.

The ratings agency will introduce more qualitative economic analysis and discard factors that have turned out to be less important, such as wealth per capita.

It plans to extend the number of rankings to 15 instead of five, giving it more ''scope for analytical differentiation'', though the added layers of rankings may slow down the task of upgrading and downgrading.

Several European governments caught up in the debt crises, and which lost their AAA ratings in January, have talked about bringing in rules to limit when ratings agencies can announce downgrades, according to John Sorrell, the head of credit at investment firm Tyndall.

The sovereign ratings industry has undergone a dramatic change in the past few years, from ''being one of the most boring parts of the market to one of the more interesting''.

''Countries that have always considered themselves above the ratings now find themselves more and more under scrutiny and exposed to them,'' Mr Sorrell said.

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Moody's is asking governments and bond buyers for feedback. The changes would not affect current ratings, but could affect future revisions. The head of the Australian Office of Financial Management, which issues bonds on behalf of the federal government, declined to comment.

It is unclear how Australia's AAA rating or state government ratings will be affected.

Moody's changes will increase the impact major crises have on ratings by no longer taking into account a government's fiscal ability to deal it.

Moody's now feels sudden events can ''severely strain public finances'' and increase the risk of default, whereas previously it would not change ratings unless it saw a gradual deterioration in a government's financial position.

''Our analysis of past sovereign defaults indicates that a number of sovereign defaults have occurred in the aftermath of exogenous shocks such as banking crises and foreign-exchange crises.''

Another change is that gross domestic product per capita will be less important in rankings because Moody's believes it is a less reliable indicator of economic stability.

''As recent experience has demonstrated, wealthy countries have endured severe credit stress without defaulting on their debt. Iceland and Ireland have suffered considerable credit stress … Moreover, the recent default by Greece occurred despite the nation's per capita income ranking among the top 30 globally,'' Moody's notes.

It will now put more emphasis on growth and economic potential because ''a country with strong growth fundamentals is more resilient to shocks and cyclical disruptions than one without''.

Ireland's troubles also prompted Moody's to take credit booms into account. It says Ireland's credit growth exceeded nominal GDP growth for four years before the country went into recession in 2008. Moody's proposes to lower ratings by up to two notches if it sees a severe credit boom.